My not-so-profound thoughts about valuation, corporate finance and the news of the day!

Thursday, January 31, 2013

Market Mayhem: Lessons for Apple

In my last post, I looked at the options that investors in Apple face today. In this one, I hope to look at what Apple can learn from the market mayhem in its stock, and, in the process, adapt. As an Apple stockholder now, I am at least partly motivated by self interest, but I am also a long time Apple product user and I would like to see the company on steadier footing. So, here are some general suggestions that I would have for Apple management (though I am sure that they are much too busy tending to day-to-day business to be reading blog posts):

Build up credibility with investors: The company has to regain credibility with investors. Apple has acquired a reputation for lowballing its expected results, prior to earnings reports. Instead of making it easier for the company to beat expectations, it has led instead to markets paying little heed to the guidance. In fact, it looks like Apple is taking the first step towards doing this by adopting the Amazon strategy of giving wide bands of forecasts for expected earnings. There will be traders/analysts/investors who will be upset, and may abandon the stock. Good!!!

Be transparent: Become more open about long-term strategy and products. I think that Apple’s secrecy about new products and strategies may be a great marketing strategy but it creates an information vacuum, which is filled with rumors and fantasy. I know that Apple also worries about giving away information to its competitors, but when you are a company the size of Apple, the news will get out to your competitors any way. So, stop acting like you are protecting national security and start acting like a business!!

Take a stand: The company has to stop trying to be all things to all investors and make its stand on whether it sees itself more as a growth company or a more mature company. Picking one does not mean that the company is giving up on the other, since a mature company can still pursues growth prospects, but it does lay down markers that will determine your investor base.

Behave consistently with your choice: Once Apple makes its stand as a growth or mature company, it has to behave consistently. Thus, if it decides that it is a mature company, it should return more cash to its stockholders, though I think stock buybacks make more sense to its stockholder base now than dividends do. At the moment, with its huge cash balance, it clearly does not make any sense for Apple to borrow money, but somewhere down the road, it has to consider the debt option, since not using it is depriving itself of the tax benefits embedded in the tax code for using debt instead of equity.

I know... I know... All of this will make Apple a more boring company, but I do have one avenue that the company should explore that can still provide excitement to investors, while also creating value. Apple’s great successes in the last decade have come from “creative destruction”, where it has gone into established markets with game changers – retailing with iTunes and Apple stores, portable music players with the iPod, the cell phone market with the iPhone and the tablet market with the iPad. Its success in each of these markets has made it a large player in each of them, which is a problem. As Clayton Christensen, Harvard’s strategy guru, notes, it is difficult for established players to be "disruptive innovators" because they have too much to lose, and Apple can no longer afford to be revolutionary in any of its existing markets. It has two choices. It can put its youthful, creative destruction ways behind in and grow up, or it can go for creative destruction in new markets. I think it should try for a combination, playing defense in the smartphone and tablet markets, and using its competitive advantages to crack open new markets. Unlike Samsung or Microsoft, Apple has never been just a technology company. Its strength has always come from a unique mix of design (software & hardware), elegance and efficiency, and it is this combination that has given it pricing power.

So, where should Apple look next? I would suggest looking for businesses where existing companies churn out poorly designed and consumer-unfriendly products, but are trapped by a lack of imagination and legacy choices into continuing down that path. I can think of at least a dozen that I use or interact with on a day-to-day basis. While televisions have been bandied about as the next big Apple market, I don’t see why the business has to be electronic. I am sure that my airline experience would be better on Apple Air, my hotel stay more comfortable at Apple Hotels and my tax money better spent with Apple Government.

I'd like to see Apple get into the enterprise business more: making their smartphones/tablets more enterprise happy, and additionally offering software to enterprises. Can you imagine an Apple accounting software? Or Apple inventory management platform? I think there are a lot of avenues on the software side for Apple to show its creativite approach to problem solving and user experience, while slowly refining their cash cows (I-Gadgets) to maximize profits.

Learning from Infosys, do you think projecting oneself as a lot more socially/societally responsible helps draw out a larger set of investors - for eg., apple does not talk about CSR or about the "green" credentials of their products. Apple tends to focus excessively on the "user experience" - a lighter iPad probably means fewer precious metals as well. Working with universities enrichening their knowledge, selling their products to the US governments etc. all have value if presented the right way. Any thoughts ?

Every great CEO is a great salesman for his company. Jobs had that role in his DNA. He was a relentless and unapologetic champion for Apple, never failing to point out in the bluntest terms the weakness of his competitors. Tim Cook is a gentleman. In his tenure, I don't think he's ever mentioned a competitor by name much less stuck the knife into their weak product offerings. Jobs was acerbic, Buffett does it with humor and sarcasm; Cook is neither funny, sarcastic or acerbic.

The value of that kind of response to your competitors is that it drives the press coverage of your company and market perceptions, rather than letting the press drive your company into the ground which is what has been happening to Apple for the past six months.

Here are transcripts from two conference calls where Steve Jobs made a rare appearance for the purpose of explaining in great detail (and naming names) why Apple is a brilliantly run business and why the competition is garbage:

Fourth quarter 2008 when the economy is tumbling into the Great Recession:http://seekingalpha.com/article/100980-apple-f4q08-qtr-end-9-27-08-earnings-call-transcript

Fourth quarter 2010 where he take the opportunity to say what he really thinks about the competition:http://seekingalpha.com/article/230710-apple-s-ceo-discusses-f4q10-results-earnings-call-transcript?part=single

It's not enough to run a great business. The CEO must also be a great spokesman for the company both on offense and on defense. Tim Cook undoubtedly knows how to run the business but so far he has not been up to the job of slaying the competition. So this is one area where I think Apple needs to improve.

I also agree with you on your second point, transparency. Apple needs to figure out how to get ahead of the rumor curve. Apple should announce new innovations on its own schedule, far in advance of the actual rollout. As it stands now they have delegated that part to unnamed "informed" sources leaving them at the mercy of the rumor mongers. The more credible these soothsayers become, the more power they have to weaken Apple with negative rumors. Speak first and you take away their power to predict Apple's future (and guide market response). It's not enough for Cook to complain about the boundless source of rumors about Apple, he has to take proactive steps to cut them off at the knees, even naming names if necessary to make a a few examples of the most egregious offenders.

In short, Apple has a public relations problem that needs to be addressed at the top.

I definitely agree that it is a turn point for Apple to change..especially with increasing transparency and expectations. It was Steve Jobs' style to be covert and worked very well for Apple when he was there. It's time for Apple to recognize and respect the fact that he is gone and cannot be replaced. A lot of the hard-core fanatics on the street were fans of Steve Jobs just as much as they were of Apple. Decoupling that will be hard but necessary for Apple's future.

A lot of the excitement with apple is the expectation of greatness. If it is unsure of living up to it (as we've seen with last few products)....it is setting up for a loss of those hard-core fanatics. Unless ofcourse...it does come out with a big bang again. The rumors are galore there..so here we go again!

Apple Apple and more Apple thats all that you here in the financial news morning noon and every night. Its begining to sound like a broken record. I once heard a guy that was an investment advisor say most folks would rather be wrong about a stock but be with the crowd that likes the stock. Than be the one lone investor thats willing to buy a stock nobody else would touch but make a lot of money on the stock. This should be a clear sign to investors that its not the greatest time to get into apple stock.

In diagnostics you have used Change in EBIT*(1–t)over 10 years as 19269.48. It appears to be EBIT, not EBIT(1-t). Change in EBIT(1-t) comes to 4852. Marginal ROIC over 10 years comes to 15.62% not 62.05%.

Is my analysis correct?

2) In none of the years reinvestment equals growth divided by ROC. Why this equation is not holding good?